Wednesday, January 20, 2016

Graph For the Day: Is QE4 Far Away?

Here is an update of the graphs I used here to point to the link from QE to the stock market.

The market is down 10% since this time last year. If it stays down and falls further, look for a spike in US unemployment. I showed here that the stock market Granger causes the unemployment rate. Surely the Fed is aware of that by now. The question is: do they accept my causal explanation that sees low confidence as a self-fulfilling prophecy.

The relationship between money and asset prices may be fine in practice. But the sad problem is that neither Keynesian economics nor monetary economics accept it in theory. For both of them money is one of many financial assets. So if the amount of financial assets being held (bought) is high that means the amount of measured money must be small. This is also why the idea that asset market crashes cannot cause recessions is of very old vintage: ranging from Samuelson and Friedman to Krugman.

The graph on http://www.philipji.com/item/2015-12-05/the-fed-is-set-to-squeeze-during-a-monetary-contraction shows YoY money growth heading towards zero. My bet is that the Fed won't do anything to stop it from falling below zero until it's too late. All indications are that by the end of this year there will be a massive crash in one or more asset markets, followed by a very severe recession.

These conclusions are asinine. On the same thesis, Japan should have been the world's fastest growing economy with their stock market up over 100% in the past 3 years. The author should only look to every country, including Weimar Germany, that experienced massive asset inflation through hyperactive monetary polices, and see whether it resulted in real economic growth. The author seems to forget one of the most basic precepts of statistics: correlation does not mean causation.

FriedrichYou should look a little deeper before making uninformed comments like this. A chart is useful for displaying visual information. My claim that market movements CAUSE real economic activity is based on 1) evidence of a relationship between the real value of the S&P, measured in wage units, and unemployment that has remained stable for seventy years. (Now also documented for the UK and Germany by other researchers). 2) Evidence that the stock market Granger caused the unemployment rate. 3) A consistent theory that explains why Granger causality should be interpreted as causality in the sense in which we think of that term in everyday speech.

While there is much to admire in the work of your namesake, your comments are a firm indication that his epigones are less impressive.

Roger, you might be interested in this. The author's model does tend to confirm that the Austrian Business Cycle Theory (ABCT) does correctly predict that interest rates are an indicator of recessions (red parts of data), HOWEVER, (according to his model), they've got it backwards: high (as in higher than his model's explanation for the effective federal funds rate) tend to precede recessions, not low interest rates.

What is with the alignment of the two vertical axes? On the left you start at zero and carefully mark off identical increments of $1 trillion. On the right axis, the increments are $200 each - but you don't start at zero. It looks like you started at the top with $2200 of S&P 500 arbitrarily set at the same level as $5 trillion in QE and very carefully stepped down the right axis ending at $600 just above the zero equivalent on the QE axis. I estimate $0 of QE corresponds to $583 of S&P 500. You don't do this in your BofE chart 6. There you set the zeros the same and chose scales to extend a little higher than the data. Obviously, you have to be somewhat arbitrary in how you match the scales so the slopes will look more or less steep depending on the scale, but why not start both at zero?